Reinsurer profitability and the interest rate myth

The challenge that low interest rates pose to the insurance industry seems to be considered as axiomatic. Company leaders, equity analyst and rating agencies all routinely highlight the challenges this causes.

For investment related life insurance products; fair enough. Indeed for those life companies that have offered long-term guaranteed returns, low rates can become an existential threat.

However, what, exactly, is the issue for non-life reinsurers? Of course, investment income is a fundamental part of a reinsurer’s earnings, and, since prudence drives asset allocation to be dominated by high grade fixed income investments, very low interest rates lead to very low investment income. But to suggest this is a major problem for the profitability of reinsurers is to invert ‘cause’ and ‘effect’ in reinsurance pricing.

The impact of high expected investment returns on the reinsurance industry is that it drives down premium rates. Indeed, high interest rate environments are notorious for causing carnage in the industry as carriers lose sight of the need for any form of pricing discipline and write simply for volume.

To be fair, fundamental profitability on long-tail business written several years ago with a – then- reasonable expectation of a higher interest rate environment will be impacted while it runs off. But, for short tail lines and, indeed, anything written since 2008, the only reason investment income can be held out as a problem is if the reinsurer chose to make a bet on rising future interest rates. If they think they are good enough at predicting that to make such a bet they should become bond traders.

The reality is that it is competition within the industry that is the driver of profitability, not investment income. This, though, does allow the fact of globally low investment yields to play a role, albeit indirectly. Rate pressure comes from too much capital chasing finite amounts of business. Some of that capital is in the industry because it cannot find somewhere else attractive to go. We would argue that greater innovation by the industry would increase demand but, absent that, the global investment environment is a problem. But not via reduced investment income in reinsurer P&L’s.